Unit 5

Audit
An unbiased examination and evaluation of the financial statements of an organization. It can be done internally (by employees of the organization) or externally (by an outside firm).

External Audit
A periodic examination of the books of account and records of an entity carried out by an independent third party (the auditor), to ensure that they have been properly maintained, are accurate and comply with established concepts, principles, accounting standards, legal requirements and give a true and fair view of the financial state of the entity. Periodic or specific purpose (ad hoc) audit conducted by external (independent) qualified accountant(s).

Objectives
the accounting records are accurate and complete, prepared in accordance with the provisions of GAAP, and the statements prepared from the accounts present fairly the organization's financial position, and the results of its financial operations. See also internal audit.

GENERAL METHODOLOGY OF AUDITING PROCESS

Objectives and Configuration of Work Auditing Engagement letter of Auditing Strategy of Work
Objective and configuration Size and complexity of company The auditor experience Knowledge of the type of the business Quality of the organization Internal control of the organisation

GENERAL METHODOLOGY OF AUDITING PROCESS

Planificacion of Auditing
Scope, configuration and exact date of the beginning of the work

Global Plan of Auditing

Planning, Independent expert in other matters Internal auditors Auditing risk methods The internal control

Analysis of the probabilistic series of different accounts of the financial statements

GENERAL METHODOLOGY OF AUDITING PROCESS

Auditing Program Review Techniques to Reach the Objectives Professional and Independent Opinion Audit Report of Financial Statement

Fair presentation
The financial statements must "present fairly" the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events, and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework. Financial statements shall not be described as complying with IFRSs unless they comply with all the requirements of IFRSs (including Interpretations). [IAS 1.16]

Fair presentation
Inappropriate accounting policies are not rectified either by disclosure of the accounting policies used or by notes or explanatory material. [IAS 1.16] IAS 1 acknowledges that, in extremely rare circumstances, management may conclude that compliance with an IFRS requirement would be so misleading that it would conflict with the objective of financial statements set out in the Framework. In such a case, the entity is required to depart from the IFRS requirement, with detailed disclosure of the nature, reasons, and impact of the departure. [IAS 1.19-20]

Differences between Internal and External Audit

An internal audit is conducted by the organization itself or a firm hired by them; it is a self examination. An external audit is done by an outside agency that reports to the firm's stockholders, or to another party, such as a business, a bank, or the IRS. An external audit is usually from an outside auditing company like Deloitte & Touche, Ernst & Young, etc. These companies will visit the client company for a designated period to review the books. An internal audit is usually done by employees within a company. This is to maintain controls and prevent any mistakes. An internal audit is done by the company itself. An external audit is done by auditors not under the influence of the company being audited.

Differences between Internal and External Audit

An internal audit is an appraisal of activities within company areas, whereas an external audit looks at the financial statements as a whole An internal report is normally given to managers, while an external report is prepared for shareholders, related companies, creditors, or government agencies. Internal is a concern, activity or process inside or "within" an entity (e.g. internal medicine, internal combustion). External is applied to forces or influences outside the entity (e.g. external symptoms, external hard drives).

Differences between Internal and External Audit

An Internal audit is performed by employees of your own company, usually by employees who are subject matter experts. Internal audit results are usually taken under consideration by management and improvements are made by the company in order to avoid an external audit finding which may result in the risk of citation or fine. An external statutory audit would be performed by and auditor who is employed by the government (local, state, or federal). The external auditors findings are legal and binding and may lead to citations or fines or both.

Essential features of an Effective Internal Audit Department

Independence appropriate staffing and training relationships due care (The auditor can never give a total assurance that control
weaknesses dont exist but they must be able to demonstrate that due care is exercised and their working papers are consistent. )

planning, controlling and recording evaluation of the internal control system evidence reporting and follow-up

Financial Controls
It is the responsibility of the Board of the Association to ensure that good financial controls are in place. It is the responsibility of management to ensure that the controls are operating effectively.

What controls are necessary?

the nature and extent of risks they face; the likelihood that the risks will occur; the extent and type of risk which would be acceptable to bear; the ability to reduce the incidence and impact of risks that do occur; and the cost of implementing a control compared to the benefit that would be obtained by implementing it.

Financial Control through

Budgetary Controls Bank and Cash Controls Expenditure and Purchasing Controls Investment Appraisal Payroll and Personnel Controls Controls over Assets Treasury Management

Nature of Accounting Errors

The accounting errors based on their nature can be of the following types:
Clerical Errors Errors Of Principe

Clerical Errors The errors which are committed by accounting clerks are called clerical errors. These errors are committed in the process of recording financial transactions. These take place due to the carelessness of the clerk responsible for recording financial transactions. Clerical errors are also called technical errors.

Clerical Errors
Errors Of Omission
Complete Omission Partial Omission

Errors Of Commission Compensating Errors Errors Of Duplication

Errors Of Omission
The errors committed by not recording a transaction either in the book of original entry or in the ledger book are errors of omission.
Complete Omission: Partial Omission:
Complete omission takes place if a transaction is not recorded in the journal at all. For example, goods sold to Krishna for 10,000 were not recorded in the sales book at all. Partial omission occurs if a financial transaction is recorded only partially. For example, partial error of omission occurs if goods sold to Krishna for 4000 is recorded in sales book but failed to be posted in Krishnas account.

Errors Of Commission
The errors which are committed while recording or posting a transaction are called errors of commission. Errors of commission may take place either in the journal or in the subsidiary books, or in the ledger. Such errors include posting wrong amounts, posting on wrong side of accounts, wrong totaling or carrying forward, and wrong balancing. For example, if purchase of goods for 10,000 is entered as 1000 in the journal or in the ledger, such error is called errors of commission.

Compensating Errors
Compensating errors refer to two or more errors which mutually compensate the effects of one another. If one error balances the effect of another error, then the two error are called compensating errors. For example, goods sold for 5000, but wrongly posted to the customer's account as 500. Similarly, goods purchased for 5000, but by chance, wrongly posted to the supplier's account as 500. The errors in the personal account are compensated by each other, as $ 4500 short on the debit side of the customer's account and on the credit side of the supplier's account.

Errors Of Duplication
Errors of duplication are those errors which arise because of double recording. Double posting of a transaction from journal or subsidiary books to ledger also create such errors. For example, goods sold to John, but this transaction is wrongly entered twice or more in the sales book or wrongly posted twice or more in John's account then it is called the errors of duplication.

Errors Of Principle
Errors of principle are those errors which occur by violating the principles of accounting. Errors of principle may occur due to wrong allocation between capital and revenue expenditure, or wrong valuation of assets. For example, debiting the wage account instead of machinery account for the wage paid to the mechanics used for the installation of machine and debiting the customer's account instead of cash account for the cash sales made. Errors of principle may also occur due to wrong valuation of assets by higher level staff.

Frauds

Fraud
It is intentional deception, lying, and cheating and the opposites of truth, justice, fairness, and equity to manipulate another person to give something of value.

Types of Frauds
Asset misappropriation
It includes things like check forgery, theft of money, inventory theft, payroll fraud, or theft of services.

Bribery and corruption

It includes schemes such as kickbacks, shell company schemes, bribes to influence decision-making, manipulation of contracts, or substitution of inferior goods.

Financial statement fraud

This type of fraud centers on the manipulation of financial statements in order to create financial opportunities for an individual or entity.

Methods
Inventory and Other Assets Theft Supplier Kickbacks
Corruption schemes misappropriations rather than asset

Financial Reporting Misrepresentation

a material misrepresentation resulting from an intentional failure to report financial information in accordance with generally accepted accounting principles.

Preventive Methods
Inventory and Other Assets Theft
Proper Documentation Segregation of Duties Independent checks Physical safeguards

Supplier Kickbacks

Financial Reporting Misrepresentation

Bribery Prevention Policy Reporting Gifts (employee) Discounts ((employee personal purchase) Business Meetings (Entertainment and services offered by a supplier or customer)

Preventive Methods
Financial Reporting Misrepresentation Establish effective board oversight of the tone at the top created by management. Maintain accurate and complete internal accounting records Promote strong values, based on integrity, throughout the organization